FASB Clarifies Scope for Expanded Disclosures for Offsetting

Abstract:  The Financial Accounting Standards Board (FASB) recently issued guidance making it clear as to which situations a 2011 standard on expanded offsetting disclosures applies. The guidance, found in Accounting Standards Update (ASU) 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, narrows the scope of offsets that will require expanded disclosures. This article provides an overview of offsetting, the initial disclosure requirements and the revised requirements.

FASB responds to a bit of criticism

In a response to stakeholder concerns that Accounting Standards Update (ASU) 2011-11 was too vague and would result in diversified practice, the Financial Accounting Standards Board (FASB) recently issued guidance clarifying which types of transactions will be subject to enhanced disclosure requirements for companies that offset assets and liabilities on their financial statements.  Stakeholders questioned the scope of ASU 2011-11, which would add significant cost to companies without adding intended value. The updated guidance, found in ASU 2013-01, Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, narrows the scope of offsets that will require balance sheet disclosures and avoid any unintended consequences. 

The offsetting dilemma between GAAP and IFRS

For some years now, FASB has been working with the International Accounting Standards Board (IASB) to converge U.S. Generally Accepted Accounting Principles (GAAP) with International Financial Reporting Standards (IFRS). Under IFRS, it can be more difficult for financial instruments to qualify for offsetting as GAAP allows exceptions for certain derivative and repurchase agreement arrangements. As a result, similar circumstances under both GAAP and IFRS can bring about very different requirements making financial statements difficult to compare. As part of this project, the two bodies proposed new criteria for offsetting that were more limited than the existing GAAP criteria. This was the intent of ASU 2011-11.

So, what is offsetting?

Offsetting is the practice of using a net amount for an asset and a liability to show a single amount on the balance sheet, rather than showing separate gross figures for both the asset and the liability. GAAP permits offsetting for derivatives that are subject to legally enforceable netting arrangements with the same party, even if the offset rights are available only in the event of default or bankruptcy.

For example, a company might have a derivative asset with a fair value of $200 million and a derivative liability with a fair value of $150 million, both with the same party. If the criteria are met, the company can offset the derivative liability against the derivative asset in its balance sheet, resulting in the presentation of a net derivative asset of $50 million.

As stated above, IFRS doesn’t allow the offset of derivatives and, as a result, the assets and liabilities would appear much smaller on balance sheets prepared under GAAP than on balance sheets prepared under IFRS. This disparity makes it difficult to compare balance sheets that aren’t prepared under the same standards.

IFRS     US GAAP  
Assets $200   Assets $50
Liabilities $150   Liabilities $ -

Initial disclosure requirements under ASU 2011-11

After receiving feedback from their respective stakeholders on their proposed criteria for a single offsetting model, FASB and IASB opted to retain their separate existing models. They did, however, agree on new joint disclosure requirements, which FASB released in December 2011 in ASU 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities.

Under ASU 2011-11, companies must disclose the following (see an example at Appendix A):

  • Gross amounts subject to offset rights
  • Amounts that have been offset to determine the net amounts on the balance sheet
  • The net amount presented on the balance sheet
  • Expanded information about collateral pledged
  • The amounts subject to a master netting arrangement that management chooses not to offset or that do not meet offsetting requirements

That guidance required these enhanced disclosures about financial instruments and derivative instruments that are either offset on the balance sheet in accordance with Accounting Standards Codification (ASC) Section 210-20-45 (which gives offsetting guidance) or ASC Section 815-10-45 (derivatives and hedging guidance) or subject to an enforceable master netting arrangement or similar agreement. ASU 2011-11’s applicability to master netting arrangements brought to the forefront the need for revision.

A master netting arrangement consolidates individual contracts into a single agreement between two counterparties. If one party defaults on a contract included in the arrangement, the other can terminate the entire arrangement and demand the net settlement of all contracts. The disclosures are intended to allow financial statement users to evaluate the effect or potential effect of netting arrangements on the company’s financial position.

Implementation backlash

When companies began preparing financial statements in anticipation of the new requirements, they raised concerns with FASB about the standard’s intended scope, noting that many contracts include standard commercial provisions allowing either party “to net” in the event of default, similar to an enforceable master netting arrangement. They noted that implementing that broad of a scope would require a comprehensive review of all contracts to determine whether each contract contained those provisions.

For example, manufacturing companies often have netting arrangements with their customers for product and supply purchases. If such contracts were included within the scope of the new requirements, companies would need to engage in a comprehensive review of all of their contracts to determine whether each one contained such provisions and therefore required enhanced disclosures.

FASB gives some much needed clarification

In response to preparer feedback, FASB quickly issued the new guidance found in ASU 2013-01. This guidance specifically limits application of the earlier guidance to the following instruments that are the most likely to result in significant differences in presentation under GAAP vs. IFRS:

  • Derivatives (including bifurcated embedded derivatives) accounted for under provisions of ASC Topic 815, Derivatives and Hedging,
  • Repurchase agreements and reverse repurchase agreements, and
  • Securities borrowing and lending transactions.

If these instruments are subject to an enforceable master netting arrangement or similar agreement, the enhanced disclosures are required regardless of whether they’re actually offset on the balance sheet.

The guidance in ASU 2013-01 makes clear that the guidance in ASU 2011-01 doesn’t apply to unsettled regular-way trades (trades that are settled within the normal settlement cycle for that type of trade) or ordinary trade payables or receivables.

The ASU 2013-01 guidance also gives companies the option of including in their disclosures all other recognized derivatives, repurchase and reverse repurchase agreements, and securities borrowing and lending transactions to facilitate reconciliation to line items in the balance sheet.

When do I have to do something?

The guidance in ASU 2013-01 makes no change to the effective date specified in the ASU 2011-11 guidance. Companies must apply the new disclosure requirements for annual reporting periods beginning on and after January 1, 2013, and interim periods within those annual periods. The required disclosures should be provided retrospectively for all comparative periods presented on a balance sheet.

I have questions. Who should I contact?

If you have questions about whether the new requirements affect you or how to comply with them, we’d be more than happy to provide guidance. Please contact Ray Quintin, Technical Director of A&A Professional Practices at rquintin@cbh.com or 704.377.1678.

 

Appendix A